Question 4

A CoastalTown in Alaska is considering to allow offshore drilling. There is a 0.01 chance that accident resulting in spill might occur. Without the spill project would results in $250 million in revenues for the town, if spill occurs the town will only receive $10 million in revenues due to clean-up costs. Suppose, that there exists a specialized equipment that would have allowed for an easy shut-off in the case of accident, resulting in loss of only $50 million from the original revenue in case of the spill. The equipment, however, itself costs $50 million to install.

a)Write a table of normal form game.

b)What is expected revenue of CoatalTown with and without equipment? Would you install the equipment based on expected revenue? Why or why not?

c)Now suppose, that people on CoastalTown have utility of income u=. What is expected utility with and without equipment installed? Would you install the equipment using expected utility?Are the outcomes in b) and c) the same or different?

d)Now imagine in a given year a probability that a spill will occur increased to 25%. Payoffs are the same as in original question. Repeat parts b) and c) using increased probability of spill.

e)Are the outcomes the same or different using expected revenue and expected utility? Explain why.